Cabot Oil & Gas Drills For Gains In U.S. Energy Boom

Having a laser-sharp focus in business is an important element of success. And for Cabot Oil & Gas, its focus on the Marcellus Shale has paid off handsomely.

Not only is the Houston-based oil and gas explorer and producer reaping results this year from the Pennsylvania shale, it's also expected to have excess cash flow in 2014.

The company will then need to decide what to do with the free cash flow: issuing a dividend increase, repurchasing shares, exploring new ventures or accelerating development of existing acreage positions. That's a good problem to have.

About 95% of Cabot's (COG) production comes from the Marcellus Shale, where the company has a 200,000-net-acre position from which it generates natural gas. The remaining 5% comes from Texas-based Eagle Ford, where the company has been drilling for oil.

Cabot's management believes the Marcellus Shale could yield more than 3,000 potential drilling locations over time. This translates into a 25-year inventory and production rates of 44% to 54% in 2013 and 30% to 50% in 2014.

"I'm pretty bullish on the Marcellus, which is the heart of this company," said Canaccord Genuity analyst Robert Christensen. "Natural gas is going to be developed by this company over the next 20 years."

He cites several factors that will put the company in an advantageous position. "It's going to be the lowest-cost, largest natural gas play ever to be had in the U.S."

The nation's energy outlook has been improving. In October the Energy Information Administration estimated that the U.S. will be the top producer of petroleum and natural gas hydrocarbons combined this year, passing Russia and Saudi Arabia. Tuesday, the International Energy Agency's calculations pegged the U.S. as leader in oil output in 2015, two years earlier than expected.

The Right Rocks

One of the contributing factors to low-cost production is the quality of the rock, which absorbs more natural gas than in other areas of the U.S. Cabot "chose the rocks that really make a difference," Christensen noted.

Another factor is the increased efficiencies that Cabot is able to realize in the area. Technological improvements as well as better gathering, processing and transporting of natgas allow Cabot to have a lower cost structure than its competitors have.

Thanks to the company's extensive experience in the region and improved technology, it's been able to reduce drill times from 22-25 days to 12-15 days, noted Global Hunter Securities analyst Curtis Trimble.

Having a laser-sharp focus in business is an important element of success. And for Cabot Oil & Gas, its focus on the Marcellus Shale has paid off handsomely.

Not only is the Houston-based oil and gas explorer and producer reaping results this year from the Pennsylvania shale, it's also expected to have excess cash flow in 2014.

The company will then need to decide what to do with the free cash flow: issuing a dividend increase, repurchasing shares, exploring new ventures or accelerating development of existing acreage positions. That's a good problem to have.

About 95% of Cabot's (COG) production comes from the Marcellus Shale, where the company has a 200,000-net-acre position from which it generates natural gas. The remaining 5% comes from Texas-based Eagle Ford, where the company has been drilling for oil.

Cabot's management believes the Marcellus Shale could yield more than 3,000 potential drilling locations over time. This translates into a 25-year inventory and production rates of 44% to 54% in 2013 and 30% to 50% in 2014.

"I'm pretty bullish on the Marcellus, which is the heart of this company," said Canaccord Genuity analyst Robert Christensen. "Natural gas is going to be developed by this company over the next 20 years."

He cites several factors that will put the company in an advantageous position. "It's going to be the lowest-cost, largest natural gas play ever to be had in the U.S."

The nation's energy outlook has been improving. In October the Energy Information Administration estimated that the U.S. will be the top producer of petroleum and natural gas hydrocarbons combined this year, passing Russia and Saudi Arabia. Tuesday, the International Energy Agency's calculations pegged the U.S. as leader in oil output in 2015, two years earlier than expected.

The Right Rocks

One of the contributing factors to low-cost production is the quality of the rock, which absorbs more natural gas than in other areas of the U.S. Cabot "chose the rocks that really make a difference," Christensen noted.

Another factor is the increased efficiencies that Cabot is able to realize in the area. Technological improvements as well as better gathering, processing and transporting of natgas allow Cabot to have a lower cost structure than its competitors have.

Thanks to the company's extensive experience in the region and improved technology, it's been able to reduce drill times from 22-25 days to 12-15 days, noted Global Hunter Securities analyst Curtis Trimble.

"If you look at the behavior of the stock, it's been amongst the best performers for the past year and a half, and that's despite a very challenging natural gas price environment," said Trimble, speaking of stocks in his energy coverage area.

"Cabot has done an excellent job of lining up transport capacity and contracts for gas, and this has allowed them to retain a more resilient price basis than many of the competitors in the Marcellus," Trimble said.

Cabot stock is up 36% this year through Wednesday, but in recent weeks has been trading off a high above 40 that it notched in early September.

During the last five reported quarters, the company's earnings per share have grown between 22% and 667% and revenue has improved between 13% and 69%. Cabot's third-quarter report, delivered Oct. 24, showed a 64% EPS gain to 18 cents on sales up 47%, to $435.9 million.

Industry Group Performs

Cabot is the ninth largest by market capitalization in the 102-company Oil & Gas-U.S. Exploration & Production industry group. This group, whose largest constituents are EOG Resources (EOG), Anadarko Petroleum (APC), Noble Energy (NBL) and Pioneer Natural Resources (PXD), is ranked No. 6 in performance of 197 that IBD tracks. It's up 38% year to date through Wednesday, but like Cabot is trading off its highs.

Cabot recently divested some minor assets in Oklahoma and Texas so it could further streamline operations and focus on only the best areas.

The company expects to have 100 net wells in the Marcellus region this year and 130 to 140 net wells next year. It will have seven rigs in Marcellus and two in Eagle Ford in 2014. Eagle Ford drilling should result in 30-35 net wells in 2013 and 40-50 net wells next year.

Cash Is Coming In

Analysts forecast that Cabot will generate $1.1 billion in operating cash flow in 2013, which should fund all or nearly all of the firm's capital investment requirements. In 2014, Cabot is estimated to produce $1.6 billion in operating cash flow, of which some $300 million will be in excess.

The company will then be evaluating potential uses for the extra cash. It has a $10 million share repurchase authorization and it could also increase or offer a special dividend. It did this in July, when it doubled its dividend and announced a 2-for-1 stock split.

Drilling, Moving, Selling

Cabot's midstream operations also have been improving. The company's gas marketing has transportation contracts and long-term sales agreements with durations of eight to 15 years on many pipelines that provide access to various markets, wrote Barclays Capital analyst Jeffrey Robertson in a research report. Cabot currently transports gas on three interstate pipelines and there could be others in future years.

It also established a partnership with Williams Cos. (WMB) to build gathering, dehydration and compression infrastructure to bring gas to the interstate pipelines.

"Low-cost production is marketable and when it's abundant, it's more marketable," Christensen said. Having access to power plants, committing your gas long-term to an interstate pipeline or to industrial facilities ". . . to the extent you have that long-term supply and to the extent it's low cost, you have an edge in moving your gas out of the region."

The firm has begun trying dual-fuel gear using natgas to help power the fracking. View Enlarged Image

Some of the risks for Cabot's business include natgas prices and the quality of the free cash flow reinvestment choices next year. However, Christensen believes that the price pressure risk is overdone. He noted that the company's marketing force is very strong and that a lot of action is taking place behind the scenes, to do with the infrastructure and improving access via various pipelines.

Management has improved significantly over the past several years, analysts say.

"When CEO Dan Dinges came in, Cabot was not perceived amongst the highest-quality operators," Trimble said. "I think what you see is a company willing to take their lessons learned and apply those." The evolution of the quality profile of the company "very much has mimicked the massive increase in shareholder value," Trimble said. "I don't think they'd get to where they are in terms of share price without a very high-quality level of execution."

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